Trump's Trade War Forces Chinese Firms to Adapt or Die

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Shoe maker Zhu Jun says he broke down in tears when a city court seized his dream car.

Zhu's Wenzhou Yi He Footwear Ltd. had collapsed two months before as stretched customers delayed payments and Zhu couldn't provide the collateral he needed to borrow more money. His Audi Q7 was sold by a court on China's east coast to pay the company's workers.

“It's too cruel for private companies,” said Zhu in an interview at the five-storey Wenzhou International Shoe Mall, which was almost deserted on a Thursday morning this month during the peak buying season. “The payment issues were never so severe in the four years my company existed.”

Wenzhou, a city made famous by the billionaire entrepreneurs it spawned during the heyday of China's manufacturing ascent, has an air of crisis, caught in a barrage of shocks that are hammering the nation's mighty industrial machine. In the yellow-walled wholesale shoe mall that was once a key source of the city's wealth, the U.S. trade war, weak domestic demand, rising costs and government crackdowns on shadow financing and pollution are all taking a toll.

Even before the trade dispute with China's biggest customer, the government's task to shift the economy away from sweatshop industries toward services and leading-edge technologies was difficult. Total debt is more than two and a half times gross domestic product and on Monday economists predict the government will announce growth last year was 6.6 percent, the slowest in almost three decades. Business confidence is deteriorating and consumer spending is slowing.

Behind the numbers is a sea change under way in the structure of China's economy, and by extension, the world's. While global economic activity tends to go in cycles, the upheaval in China is more far reaching. The government's effort to pivot from being the world's supplier of goods to a nation that's increasingly competing for technological dominance is shaking up the global order.

“Many companies are failing and surging costs have put a heavy drag on business,” says Tao Dong, vice chairman for Greater China at Credit Suisse Private Banking in Hong Kong. “But this also forces a transition. In a few years, I expect the Chinese economy to look quite different.”

Outside Wenzhou's shoe mall, empty stores dot the potholed, muddy streets in the western part of the city. At shoe-sole maker Sen Nan Shoe Materials Ltd., sales manager Li Xiang says it will close the store soon to save 200,000 yuan a year in rent. The shop now gets only one or two customers a day and there's no point keeping it open, she says.

In this port city of 9 million people in the southeastern province of Zhejiang, companies that have escaped the downturn tend to be the ones doing a better job of adjusting to the economy's transition.

Midpoint Group, a maker of gadgets such as voice-controlled lighting, as well as blood-pressure monitors, saw profit rise 10 percent last year on revenue of 200 million yuan ($29.6 million), says Chairman Zhu Chenghua. The one-time maker of toilets and power switches says they have kept ahead by shifting into higher-value goods and spending 5 percent of revenue on research and development. This year, it will launch a camera-based system to monitor the elderly at home.

Unlike previous downturns, policy makers have refrained this time from pumping in borrowed money to buoy growth. Instead, they've stuck to targeted stimulus measures in an effort to pilot a gradual slowdown.

Monday's data may show industrial production in December slowed to 5.3 percent, while fourth-quarter GDP growth was 6.4 percent, the slowest three-month period since the depths of the global financial crisis a decade ago, according to the economists poll.

Whether President Xi Jinping can succeed in guiding growth gently lower without triggering a slump is keeping investors nervous.

Their worries were eased a little this week when credit data for December came in above expectations and policy makers vowed deeper tax cuts. Economists see growth slowing to 6.2 percent this year and 6 percent in 2020.

“Chinese officials face a delicate calibration challenge,” said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong. “It requires considerable finesse, delivering targeted support to industries moving up the value chain but also keeping sufficiently tight reins overall to encourage resource allocation away from sectors that no longer offer the desired returns.”

A key part of the challenge is to restore the confidence of private-sector businesses that contribute 60 percent of gross domestic product, 80 percent of employment and 90 percent of new jobs. Many of those companies have been hit by the crackdowns on financing and pollution, which tended to favor big, state-owned enterprises that have easier access to loans from government-run banks, and deeper pockets to meet higher environmental standards.

A Wenzhou-based online lending platform, whose managers asked not to have their company named, is one of the victims of the government shadow lending crackdown, which was spurred by a wave of defaults and investment scams.

The peer-to-peer finance site received a government notice in November to halt new operations and clear outstanding loans, a company manager said. Its activities include lending to farmers in the Inner Mongolia region. Now it may have to close.

There's a need for online financing because some people really can't borrow from banks, the manager said.

Wenzhou's shoe industry shifted toward supplying domestic consumers five to six years ago after many manufacturers serving international markets relocated to nations like Vietnam to avail of cheaper labor, said Hu Sheng, owner of Xia Bai He Women's Shoes Ltd. in the footwear mall. That means the trade war's impact on the city's output is mostly via a drag on consumption and the overall economy, he said.

Xi responded to the private enterprise pain with an unprecedented push to cajole banks into lending more to small companies. He put his personal stamp on the campaign, proclaiming “unwavering” support for the sector. A blizzard of policies to help reduce costs followed, including pledges to reduce value-added tax, tax exemptions for small- and middle-sized companies and lower social security premiums.

While Midpoint, the maker of higher-tech home appliances, said they have benefited from some government measures, most companies interviewed in Wenzhou this month said they've yet to see any positive impact. Hu says his company was forced to move to an expensive industrial park and now pays more taxes, not less.

He's cutting back production because of weak domestic demand and says he's considering relocating to his home town of Huanggang in central China's Hubei province, the place he left 20 years ago for Wenzhou to escape poverty. But even relocating inland to seek cheaper labor and rent may only be a temporary respite for companies as the country goes through the trials of recasting its economy.

“Private enterprises are facing more challenges and pressure due to the deteriorating economic slowdown from an already difficult situation,” said Zhou Dewen, Deputy Director of the China Association of Small and Medium Enterprises. “China needs to live through bitter days for several years as it restructures its economy, but eventually it can have a bright future.”

To contact the editor responsible for this story: Jeff Black at jblack25@bloomberg.net, Malcolm ScottAdam Majendie

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With assistance from Bloomberg